Prompt crude futures continued to weaken Friday, with both NYMEX crude and ICE Brent struggling to hold at levels last seen just ahead of the OPEC-led deal in late-November to cut output.
In the afternoon, NYMEX April crude was around $48.50/b, while ICE May Brent was $51.30/b, down 8% and 9% from Tuesday, respectively.
The recent correction has surprised many, especially in light of OPEC member's 98.5% compliance with agreed cuts, according to a recent survey by S&P Global Platts. Despite this, there have been a number of signals suggesting supply-led strength was likely to be short-lived.
Quantifying surprise is difficult, but examining implied volatility can help do just that, especially considering how extended speculative net length has become.
Until the recent correction, prices had been holding in a narrow $50-$55/b band, with upside support driven in part, at least for NYMEX crude, by near-record open interest and speculative length, and until Wednesday, weak implied volatility.
CQG data pegs NYMEX crude open interest across the strip at around 2,165,703 contracts, while Commodity Futures Trading Commission data two weeks ago showed money manager net length at a record 405,328 contracts. Implied volatility -- a measure of how much risk is priced into the market -- had fallen to just over 20% at the beginning of March.
Implied volatility in crude often remains dormant when prices are range bound or rising, only spiking when the market expects values to fall. Since Wednesday, implied volatility in prompt NYMEX crude has jumped back up to nearly 34%.
And while this reaction in implied volatility could suggest the supply-led exuberance may have run its course, it should not come as a surprise.
While it is true that OPEC and non-OPEC countries alike have largely agreed to reduce output, narrow Brent/Dubai Exchange of Futures for Swaps and WTI/Dubai spreads have allowed non-Middle East crudes to help fill supply gaps left by OPEC cuts. North Sea, West African and both North and South American barrels have been pouring into Asia, mitigating the intended tightening effects of fewer Middle East sour barrels on the market.
US production has also helped offset the loss of OPEC barrels. The uptick in crude prices into the $50s following OPEC's announcement was welcome news for US shale producers who then returned drilling rigs to service to capitalize on higher prices.
Upstream operators also seized the opportunity to hedge output by selling crude futures. The short position in NYMEX crude futures held by producers reached a record high in mid-February. That hedging activity helps insulate producers from any downturn in spot crude prices, further boosting the possibility that US production is likely to keep growing.
US crude stocks continue to push record levels, helped in part by steady imports from Saudi Arabia, suggesting that if the supply giant has indeed cut output, it has left its supply chain to the US largely unaffected. And while part of the build in US stocks came amid seasonal refinery maintenance, the resumption of runs -- especially on the US Gulf Coast -- has failed to sustain higher crude prices.
Further downside pressure across the complex has come from glutted US product stocks. Gasoline and diesel stocks on the US Atlantic Coast -- home to the New York Harbor-delivered NYMEX RBOB and ULSD contracts, which benchmark spot prices across the globe -- are well-above their respective five-year averages.
USAC gasoline stocks were pegged at just over 71 million barrels this week, according to US Energy Information Administration data, down slightly from record levels set in early February.
ASIA/EUROPE REFINERY WORK LIMITS CRUDE DEMAND
Most recently, however, has been the massive amount of refinery work -- both planned and unplanned -- across much of the Europe and Asia. And while this is only a temporary hit to crude demand, a renewed bullish outlook faces two hurdles once these refiners return to full production.
First, spreads continue to support North Sea, WAF and Americas arbitrage flows, even if there is currently a lull in demand for any crude. Were refiners across Asia to resume runs immediately, there is little reason to suggest a change in spreads supportive of the arbitrage.
In fact, refinery work in the ARA consequently cuts local demand for Atlantic Basin crudes, making them all the more attractive for those refiners in Asia still running at full tilt.
Second, an argument can be made that Asia and Europe maintenance will tighten product markets and in turn keep the oil complex supported. But these markets remain well-supplied, according to IE Singapore data released this week. Singapore's light distillates stocks, including gasoline, reformate and naphtha, rose to a one-month high of 13.9 million barrels in the week ended March 8. Combined middle distillates stocks in Singapore rose to a three-week high of 13.018 million barrels.
This has weighed on Singapore product values, from differentials to crack spreads. Singapore 92 RON was assessed Friday at the Mean of Platts Singapore strip minus 15 cents/b, down from a 30-day average of plus 13 cents/b. Jet/kero cargoes, which barely broke into positive territory this winter, were assessed at MOPS minus 38 cents/b Friday, down from parity as recently as February 23.
